At some point in your trading, you will be tempted to play an oversold stock.

You’ll see the first signs that a stock locked in a nasty downtrend is about to recover. And you’ll want to immediately buy shares to play the inevitable bounce…

But it’s not that simple. Attempting to call a bottom of a sharp downtrend is one of the most difficult (and most risky) trades on the market. That’s why it is so important to analyze a chart before putting on a trade. As I’ve said many times before, three minutes of work can save you from making a mistake that could potentially cost you thousands of dollars.

Today, I’m going to review a two of the most popular tickers you’ve sent in over the past two weeks. Both are sub-$1 stocks that are trying to bounce off their lows–but only one is setting up for a potentially profitable trade.

The first stock is Sefe Inc. (OTC:SEFE):
After an impressive run-up in April, SEFE fell from a high of $2.75 to below 25 cents in just 6 weeks. And if you tried to play the small bounces in mid-May and mid-June, you probably would have gotten burned.

It’s tempting to look at a quickly falling stock like SEFE and assume that it can’t fall any lower. But as the chart shows us, the stock can and did continue to find lower ground. And it might not even be finished dropping just yet…

The main mistake in trying to play a bounce here is that the stock has not yet started to form a legitimate bottom. This means that the price has not stabilized and consolidated for any significant time period.

I added a 20-day moving average (blue line) to show you how strong the downward pressure has become on this name. Since SEFE fell below the blue line in May, it has not been able to break above it–even after the strong 2-day rise in late June.

SEFE isn’t a trade you’d want to try on the long-side. Even at 28 cents, shares would need to overcome the falling moving average. And with support all the way down toward 20 cents–the most recent significant low–it’s simply too risky to trade at this time.

This next example is a much better example of a potentially tradable bottom. The stock is OncoSec Medical Inc. (OTC:ONCS):
Much like SEFE, ONCS fell from highs close to $1 in March to about 15 cents. But unlike SEFE, this stock is displaying a nice rounding bottom. Notice how the price action from April through June is shaped like a big bowl. After the final washout, ONCS spent the better part of May and June solidifying support at 15 cents. The stock has moved above its short-term moving average and is now showing signs of strength.

This is an ideal setup when you’re looking to trade a stock coming off its lows. The most important thing to remember is to look for confirmation. Note the volume spikes last week as ONCS broke near-term resistance.

Judging by the most recent price action, a very short-term trader might soon see a suitable entry point around 25 cents. On the other hand, a more conservative swing trader might want to wait until the stock retests and bounces higher off its short-term moving average at 22 cents.

Sincerely,

Greg Guenthner

Related Posts

• June 15, 2012 -- How To Spot a Good Trade
• October 12, 2011 -- Back From The Brink?
• January 25, 2011 -- Chart Smarts: Why You Should Expect Continued Gains in Stocks
• May 18, 2009 -- Pullbacks Create Buying Opportunities
• June 25, 2012 -- How to Trade This Auto Stock

Greg Guenthner

Greg Guenthner, CMT, is the co-editor of STORM Signals and Penny Stock Fortunes. He is also the editor of Agora Financial’s Trend Playbook, a free resource for trend followers and technical traders. For close to a decade, Greg has led Agora Financial’s small-cap division, where he founded one of one of the only independent OTC research advisories in the industry. Greg specializes is classical trading techniques and combines timing strategies with his fundamental analysis of small-cap stocks.

He is a member of the Market Technicians Association and hold the Chartered Market Technician designation. 

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